Recently, I found myself looking at a high-growth stock wondering why I had not invested in the company when other investors had and made quite a bit of money doing so. I always like to review errors like these to see where I went wrong. After reviewing the investment, I concluded that I had been too cautious.
This presented a bit of a dilemma. I have always been a relatively cautious investor, which means I have missed out on the explosive growth in some sections of the market over the past 12 months.
Based on this performance, I have started to question if my strategy is too conservative. There is never going to be a definitive answer to this question. The question of whether or not one is being too cautious depends on one's own mindset.
However, I think I have been too harsh on myself on this occasion. After concluding that I had been too cautious, I remembered the inversion principle, which was missing from my initial analysis.
Invert, always invert
Charlie Munger (Trades, Portfolio) once said, "All I want to know is where I'm going to die, so I'll never go there." This thinking was inspired by the German mathematician Carl Gustav Jacob Jacobi, who developed a simple strategy for solving complex problems.
As Munger once explained, "[Jacobi] knew that it is in the nature of things that many hard problems are best solved when they are addressed backward." Jacobi's strategy was, "invert, always invert."
This strategy has multiple applications in life, but for investors, it is useful for avoiding difficult situations. When one considers a potential investment, it is worth considering both the positives and negatives of any argument.
The mistake I made when evaluating my recent error was that I did not contemplate what might happen if the world goes back to normal. Over the past 18 months, certain companies have experienced a goldilocks-style operating environment. Stuck-at-home consumers have had no choice but to use certain products, generating windfall profits for companies. Record low interest rates have also resulted in more (borrowed) money going into circulation in the economy in one form or another, whether it be through company investments, payrolls or new houses.
In hindsight, it is very easy to say which companies have benefitted and which have not. However, at the beginning of 2020, it was far more difficult. It is just as challenging today to try and predict which companies will be outperforming and which will be struggling 12 months from now.
Therefore, in reviewing companies today, it is essential to ask if they will still be in the position they are today in 12 months' time. In my case, rather than asking what I missed, I have been asking why I missed it.
I made an error avoiding certain companies during the pandemic, but it would have been impossible for me to find those companies before the pandemic began. I could have compounded this error by investing in companies that performed well during the pandemic but might not be able to sustain their growth afterward.
To put it another way, my error was twofold. In my initial debriefing, I failed to realize growth may not last forever, but I was also being too hard on myself in the first place. A combination of this, as well as a fear of missing out, could have led me into growth stocks I did not understand.
This is something every investor needs to consider in the current environment. In a market where fortunes are being made and lost overnight, investors need to consider not just what could go right, but what could go wrong and how much money could be lost as a result as well. The best way to find a solution to these questions could be to invert the problem.
